U.K.’s Office of Tax Simplification Takes Aim at Inheritance Tax
The Office of Tax Simplification (“OTS”) is reviewing the UK’s Inheritance Tax (“IHT”) regime, with specific focus on both process and administrative issues associated with IHT. It is also looking at more technical areas including disclosure, estate planning and the plurality of available reliefs.
The OTS has confirmed that it is hoping for “genuine, substantive simplification,” as opposed to “a bonfire of taxpayer reliefs and exemptions,” however, there are a number of areas where the law looks ripe for reform.
One area often singled out as an area of particular complexity is the myriad of lifetime exemptions and reliefs from IHT. Such exemptions include the Potentially Exempt Transfer (“PET”) regime, the spouse/civil partner exemption, the annual exemption and the exemptions for small gifts, gifts on marriage and gifts made out of normal expenditure from income. In addition to the above, there are reliefs for business and agricultural property, including Entrepreneurs Relief, Business Property Relief (“BPR”) and Agricultural Property Relief (“APR”).
Coupled with the above is the nil rate band (“NRB”) at which assets are taxed at 0 percent. Transferrable between spouse’s estates, the NRB has remained flat at 325,000 pounds since 2009 and looks set to stay that way until at least 2021.
The introduction of the residence nil rate band (“RNRB”) has added another layer of complexity. This is an additional tax-free sum that can be claimed by estates where a “residence” is “closely inherited’ by “lineal descendants.” Currently worth 125,000 pounds, but increasing to 175,000 pounds by the year 2020–21, the additional tax-free sum, will, when combined with the basic NRB, offer individuals the opportunity to pass on 500,000 pounds of assets free of IHT (1 million pounds for married couples).
The matter is, however, complicated by the fact that the relief is subject to a tapered withdrawal where estates exceed 2 million pounds and lost entirely where estates exceed 2.35 million pounds. This “use it or lose it” element has added an additional layer of complexity to tax planning, particularly for couples whose individual assets fall below the upper threshold (2.35 million pounds), but whose combined assets (on the second death) will likely exceed it. In short, the RNRB has been a complex means of increasing the threshold at which assets can be passed free of IHT, and one which has been both poorly received (it discriminates against those without children or property) and under-utilized (only one in six estates have claimed the relief).
It is ironic that, having been designed to reduce the numbers of estates caught by the IHT net as a result of rising property prices, IHT receipts have nevertheless hit a record high in 2017–18 of 5.2 billion pounds.
It is unsurprising then that the area is set for reform, however, the real question is how radical such reform will be. Individuals could see some of the more under-utilized lifetime IHT exemptions removed (such as those for small gifts/gifts on marriage etc.), with the annual exemption, hopefully, increased accordingly. Such a step is a long time coming—the annual exemption having been stuck at 3,000 pounds per annum since 1981.
The government could also make changes to the RNRB, either cosmetically, by increasing the definition of “lineal descendants” to include nieces/nephews (“lineal descendants” only includes children/grandchildren), or more radically, by doing away with it entirely and simply increasing the basic NRB.
The OTS Call for Evidence
Such a step is not entirely fanciful if the wording of the OTS’ Call for Evidence is anything to go by, as the final question regarding the wider IHT system does ask whether some IHT exemptions should be removed to fund “a lower or graduated rate or higher NRB”. Unfortunately, this may be reading in to things a little too much, given that the RNRB was only introduced in 2017 and is only mentioned specifically once, in a catch-all question at the end of the document regarding “other areas of complexity.”
Interestingly, one area which the Call for Evidence places a lot of emphasis on is the IHT treatment of businesses. This follows a separate publication from the OTS earlier this year entitled “Simplifying the taxation of key events in the life of a business,” which also featured significant discussion of Business Property Relief (“BPR”) and the interplay between this IHT relief and other capital gains tax (“CGT”) reliefs relating to businesses, including CGT hold-over relief and Entrepreneurs Relief. Of slight concern is the OTS’ questioning of the extent to which these generous reliefs “distort decision making,” as well as its reference to “inconsistent definitions or approaches within IHT and across IHT and CGT which cause complexity.”
The inconsistent definitions referenced in the Call for Evidence include those for trading companies, which differ across BPR, CGT hold-over relief and Entrepreneurs Relief. Furthermore, in its paper on “Simplifying the taxation of key events in the life of a business” earlier this year, the OTS noted that “the OTS have been told on several occasions that aligning definitions would represent a significant simplification.” This may well be the case, however, such a simplification, if it were to consist of increasing the level of trading activity required for a business to qualify for relief, from the current 50 percent threshold for BPR, to the 80 percent threshold required for Entrepreneurs Relief and CGT hold-over relief, would represent a significant loss of relief for many taxpayers across the U.K.
As has been the case since the RNRB’s inception, clients should review their existing Wills and consider the extent to which their estates will benefit from the additional tax-free sum.
In particular, couples whose individual assets fall below the upper threshold (2.35 million pounds), but whose combined assets (on the second death) will likely exceed it, may wish to consider leaving a ‘residence’ or an interest in a ‘residence’ to one of their children/grandchildren on the first of their deaths, in order to utilise the relief and reduce the value inherited by the surviving spouse. Alternatively, they might consider making lifetime gifts to ensure that both estates qualify for the relief.
More generally, clients would be well advised to keep their ears peeled for any changes to be made to the IHT reliefs as a result of the consultation, as any such changes could impact existing estate planning, and, possibly, create new tax planning opportunities.
Alternatively, and most radically, the government could decide to scrap IHT entirely, defining death as a “disposal” for CGT, or instead institute a form of gift tax, whereby the recipients of lifetime gifts or those who inherit assets are taxed rather than the estate of the deceased (however unlikely this would be). Only time will tell.
John Sweeney, Associate
This article was originally published in Bloomberg BNA and can be accessed here.